How to tell if an income property is over-priced:

Investing in real estate is riskier than investing in a Certificate of Deposit, so why would an investor be satisfied with buying income property at a 3%, 4%, or even a 5% cap rate?

Real estate investment opportunities that pencil out to low cap rates like these are overpriced, because investors can earn the same rates of return in a safer investment vehicle. Investments should earn more of a return for assuming the increased risks associated with real estate investments.

With a high-yielding CD account, money can earn between 4 – 5%, safely without lifting a finger. With real estate investments, an investor assumes more work, more risk, and therefore, warrants more of a return on money invested. This assumption is practical, and makes sense from an investor's perspective.

Experienced investors of all types know that with increased risk, they can (and should) expect more of a return on their invested money. You know you are looking at an overpriced income property, if it pencils out to a cap rate of 3 – 5%. Buying properties with low cap rates like this does not make sense, because an investor can earn these rates in a safer high-yielding CD account.

CD rates as of 12/09/2006 (source cited from bankrate.com, for informational reference only.)

TYPE
TODAY
+/-
LAST WEEK

6 month CD

4.64%
4.66%
1 yr CD

4.83%
4.86%
5 yr CD

4.70%
4.72%
1 yr IRA CD

4.64%
4.66%
5 yr IRA CD

4.59%
4.60%

Smart investors compensate themselves for the added risks they assume by establishing higher performance expectations for riskier investments, including real estate.

Buying overpriced income properties does not make much financial sense. Properties that produce cap rates under 5% is overpriced, in all honesty, because you can make these kinds of returns in a safer CD investment. Risk and reward go hand in hand.